STRANGER THINGS

Brexit is making the UK economy act illogically

When Britain voted to leave the European Union in June last year, the most immediate effect was a sharp fall in the pound versus the dollar, euro, and other major currencies. While sterling has recovered somewhat against the dollar since, it is still down by 12% against the euro, not far off its post-referendum low.

In theory, this should be good news for Britain, since the EU is the nation’s most important export market, accounting for 44% of all UK exports in 2016. After all, if the pound is weak and the euro is strong, it should boost exports to many parts of Europe, since British goods and services have suddenly become a lot cheaper.

But that hasn’t happened, as noted by investment bank Citi in a recent report.

“So far, year-on-year GDP growth rates have remained resilient since the EU referendum, contradicting initial expectations of a sharp decline,” wrote Citi’s analysts. “However… a downtrend is becoming increasingly discernible, in our view. This is striking given that the UK should be benefitting from much stronger growth in the Eurozone.”

The combination of a weaker pound and accelerating economic growth on the continent—the IMF recently upgraded its outlook for several euro-zone countries—should be boosting UK growth. Also, until the UK formally divorces the EU in early 2019, it benefits from free trade with other members of the bloc.

But that looming split has put off businesses from taking full advantage, Citi says.

“At this point, one might expect UK firms to be heavily investing into new capacity to increase market share in export markets. The data suggests that they are not and that may well be due to Brexit uncertainty,” according to the analysts.

Indeed, a recent UBS survey of euro-zone firms, most of which had operations in Britain, found that a third expected to cut investment due to Brexit. The latest Deloitte poll of CFOs in the UK found that a similar share of businesses “expect Brexit to reduce their own investment and hiring plans over the next three years,” amid rising anxiety and eroding optimism.

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